Correlation Goes Mainstream

Volatility watchers, there's a new index in town.

Stay Connected

"Volatility watchers and risk managers have a new index to watch, starting next Monday: the CBOE S&P 500 Implied Correlation Index. The CBOE announced the new index in a press release yesterday, noting that the Implied Correlation Index will be tied to 2 different option maturities: January 2010 (ICJ) and January 2011 (JCJ). The values of ICJ and JCJ will be disseminated by the CBOE every 15 seconds during the trading day, as is done with the VIX.

The Implied Correlation Index doesn't calculate the correlations among the entire S&P 500 Index. Instead, it utilizes a "tracking basket" of the 50 largest components of the SPX as measured by market capitalization. For more on the calculations involved in the Implied Correlation Index and related materials, check out the Implied Correlation Index splash page, the Implied Correlation Index white paper, and historical data going back to the beginning of 2007.

I also stole Bill's chart here, with permission (at least, that's my story and I'm sticking to it).

Just to back up for a second, remember that Index volatility has 2 main drivers: One is the volatility of the component stocks; the more volatile, the higher the index volatility. The other driver is the degree to which the components correlate to one another; the higher the correlation, the higher the index volatility relative to the volatility of the components.

Individual stock volatility is easy to find. I use both my trading program and ivolatility.com. But correlation? Not so much. We can infer it, but it will be nice to have ready a number to measure it.

Warning way in advance though: Correlation has existed and been quantified in different ways forever. Don Fishback, in fact, goes so far as to create his own proprietary volatility index of components. Much the same principle in that volatility existed before they invented the VIX. So when someone finds some air tight relationship based on a couple years of a newly created number and the SPX, take it with a grain of salt.

Bottom line is, I'm very glad to have a number like this at our ready disposal, but it will be best utilized in concert with everything else.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.